LABOR REFORMS IN GERMANY: A THREAT TO

UNCLAS SECTION 01 OF 03 BERLIN 002014

SIPDIS

STATE FOR DRL/ILCSR, EUR/ERA AND EUR/AGS; LABOR
FOR ILAB
(BRUMFIELD); TREASURY FOR OASIA
USEU FOR PETER CHASE, JULIE NUTTER, BARBARA
MATTHEWS

SIPDIS

E.O. 12356: N/A
TAGS: ECON ELAB EFIN PREL PGOV GM
SUBJECT: LABOR REFORMS IN GERMANY: A THREAT TO
ECONOMIC RECOVERY?

REF: (A) BERLIN 2004; (B) BERLIN 1977

Summary
--------------


1. In the last few weeks, much has been written
about the SPD's new program to roll back labor
reforms in Germany, with the "Financial Times"
characterizing them as a German retreat from
economic reform. Whether the Beck proposals or a
government counter-proposal can be contained as a
piece-meal package or represents a wider trend
remains to be seen. The question is one of both
perception and reality. The reality is that the
reform rollbacks - primarily related to extending
labor unemployment benefits - would have little
immediate impact on the fundamental dynamics
behind Germany's economic growth. A greater
threat stems from the perception among the
business community and others that Germany is
beginning to turn its back on reform (Ref. A).
Nonetheless, Germany's economic recovery will
continue to be much more significantly influenced
by the mega-developments in the global economy
and by its own fundamental restructuring.
Ultimately, both major political parties
recognize that jeopardizing Germany's steady
economic recovery is not in their or Germany's
longer term national interest.

What is Germany Trying to Reform?
--------------


2. Social perceptions drive the current debate
on labor market rollbacks. At the heart of the
matter is the broad perception among the
population that the so-called Hartz labor market
reforms (targeted at Germany's inflexible labor
market) are mean-spirited and disadvantage older
workers in particular. The panacea - extension
of unemployment benefits to workers over the age
of 50 - is seen to be relatively cost neutral as
well socially advantageous. While the proposals
can be characterized as a rollback, they
represent but one piece of a broader economic
reform agenda (known as Agenda 2010) that touched
on a significantly broader set of issues than
just labor issues, for instance, tax reform.
Though there is active discussion on increasing
the number of rollbacks to the Hartz labor market
reform package, there has been no discussion in
Germany with regard to dismantling this broader
package of reforms.

Labor Reforms: What Has Been Their Impact?
--------------


3. The Hartz package changed the maximum
duration of unemployment benefits in an effort to
ease the pressure on pension insurance funds and
to reduce non-wage labor costs. The package also
sought to remove the disincentive for older
workers to accept jobs they considered less
attractive and to discourage early retirement at
the taxpayer's expense. Ironically, the current
rollback proposals come just at a time when the
Hartz reforms are bearing fruit. When Chancellor
Schroeder first presented his Agenda 2010 to the
Bundestag on March 14, 2003, Germany had 4.6
million unemployed; today the number is 3.45
million, the lowest level in twelve years.


4. The cut in unemployment benefits for older
jobseekers has contributed to a changed mentality
by giving strong incentives to proactively search
for work, according to the German Institute for
Economic Research and the Center for European
Economic Research. Long-term unemployment has
also fallen as flexibility increased, according
to a recent study of the Federal Employment
Agency's (BA) research Institute, IAB. One in
five companies polled reported jobseekers were

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more willing to work for lower wages, accept
irregular work hours and take on long commutes.
Even for hard to fill jobs, companies are finding
applicants more easily. This is where the
proposed roll-back that the SPD proposes is
likely to do most harm. It may halt or even
reverse this extremely positive trend.

Business Community Concerned
--------------


5. The SPD proposals have concerned the German
business community. Ludwig Braun, president of
the German Chamber of Industry and Commerce
(DIHK),commented that any extension of benefits
would give the unemployed "wrong incentives" and
"increase the risk" for the labor market. Others
warn against a general "slide back" into past
patterns of behavior. The President of Germany's
Federation of German Industries, Michael Thumann,
called upon the membership of his organization to
defend the reforms in meetings with government
and parliamentarians. The overall effect of the
proposed changes on the current upswing is,
however, likely to be limited.

Economic Boom above all a Business Success Story
-------------- ---


6. Holger Schmieding, Bank of America's Head of
European Economics, estimates that the entire
Agenda 2010 reforms (which contains much more
than the labor reform package now under debate)
contributed about one third to the current growth
rate. A dent in global economic activity could
be as damaging since the current upswing is
driven so much by global demand for German
capital goods. Moreover, German business - with
cooperation from labor unions - has done its
part. In recent years many German companies have
realigned their strategies, tapped into new
production and sales markets, and slashed costs.
While unit labor costs in the Euro area climbed
by almost 10% between 2000 and 2006, they
steadily declined in Germany as a result of wage
restraint, longer working hours and more flexible
labor input. The Hartz reforms may have
reinforced some of the wage restraint, but they
were not the engine; the wage restraints started
already in the mid-1990's - eight years before
the Hartz reforms were implemented.


7. Germany's heightened price competitiveness is
accompanied by regained technological prowess.
Among the EU-15 Germany can boast the highest
share, 65%, of innovative industrial enterprises.
The broad range of high-grade, innovative German
capital goods meets increasing demand from the
high-growth emerging markets. Germany is the
only big industrial nation to have maintained its
share of the world market. Last year alone
German shipments soared by 12.5% in real terms,
while 2007 is predicted to turn in a similar
increase. The ratio of exports to German GDP now
stands at 45% - astoundingly, over 10 percentage
points more than in 2000. As analysts across the
board agree, the effect of the proposed labor
changes is dwarfed by the threat of sluggish U.S.
and global economic growth, the surge of the Euro
and continuously rising oil prices.

Comment
--------------


8. Since 2006, Germany has been registering
rates of growth last seen in the 1998-2000
period. After years of stagnation (between 2001
and 2005 the economy grew by a mere half percent
per annum) - Germany is no longer the "sick man"
of Europe, but rather by some measures its
healthiest partner. Business, through painful
restructuring, the opening of new markets and the

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development of innovative products is the major
force behind the success. Wage restraint on the
part of labor added substantially to the decline
in unit labor costs. While government policies
have bolstered the upswing, they have only
contributed to the forces already driving growth.
The danger of the current rollbacks thus lies
more in the signal they send to investors - i.e.
that Germany is now less serious about reform -
than to their immediate impact on the economy.

TIMKEN JR